How Do Nominal and Real Rigidities Interact? A Tale of the Second Best
Munich Personal RePEc Archive Paper No. 7282
27 Pages Posted: 24 Apr 2008
Date Written: October 31, 2007
Abstract
This paper analyses the importance of real wage rigidities, in particular through their interaction with price stickiness, for optimal monetary policy in a calibrated small open economy DSGE model including oil in production and consumption. Blanchard and Galí (2007a) show real rigidities to introduce a trade-off between stabilising inflation and the welfare-relevant output gap. The present paper complements their findings by showing that the welfare cost of real rigidities can be substantial compared to nominal frictions. In a typical "tale of the second best", we also show that in the presence of real wage rigidities, price stickiness can be welfare-enhancing.
Keywords: DSGE model, price stickiness, real wage rigidity, oil price shocks
JEL Classification: E30, F41, Q43
Suggested Citation: Suggested Citation
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